SAN DIEGO – For the Red Sox, the luxury tax looms as a giant iceberg in the movement toward building a 2020 roster. The team has made no secret of its desire to dip its payroll beneath the $208 million threshold that would trigger penalties for 2020.
The Red Sox are willing to pay the luxury tax, something they’ve done in 10 of 17 seasons since something like the current form of the tax was introduced in 2003 – including 2019, when the team spent a major-league high and team-record $243.5 million on payroll.
But based on the penalties in the most recent collective bargaining agreement, the team has huge incentives to get under the threshold at least every third year.
Why? What kind of penalties – or savings – could motivate a team with exceptional revenues like the Red Sox to shake up their roster and clear payroll for one year?
If the Sox scale back their payroll to $205 million next season before returning to their 2019 level of $243.5 million in 2021 and 2022, they could save a total of roughly $90 million to $100 million over the next three years.
How? For that, it’s worth looking at the current collective bargaining agreement between Major League Baseball and the Major League Baseball Players Association, and the changes it introduced to the luxury tax threshold and the penalties for exceeding it that teams have cited as a reason for changes to their spending behavior.
Those changes included:
■ SLOW THRESHOLD GROWTH: Under the first two CBAs with something like the current luxury tax structure, the threshold for incurring penalties shot up from $117 million to $178 million – an increase of $61 million and 52 percent over 9 years (2003-11).
The last two CBAs have had modest increases, going from $178 million in 2012 to $210 million in the final year of 2021 – a $32 million increase of 18 percent in that 10-year cycle (2012-21).
■ HIGHER TAXES – ESPECIALLY FOR REPEAT OFFENDERS: The limited threshold movement might not have mattered – except that at the same time that the threshold growth slowed, the penalties for going past it increased.
The base penalty rate for a first-time luxury tax payer rose marginally from 17.5 to 20 percent. But after the Dodgers increased spending to nearly $300 million in 2015 – more than $100 million above the threshold – MLB worried about a runaway spender, much as it had with the Yankees when introducing the current form of the luxury tax with the 2003-06 CBA.
The new agreement attempted to curb extreme, repeated spending. The penalty for surpassing the threshold for a third straight year went up to 50 percent – a level that the MLBPA treated as kryptonite in the 1990s. Moreover, potentially significant additional penalties were created for teams that spent $20 million (a 12 percent surcharge beyond the base rate) and $40 million (a 45 percent surcharge on the base rate) past the threshold.
The 2020 luxury tax threshold is $208 million. If the Red Sox – after paying the luxury tax in each of the last two years – spend $228 million ($20 million above the threshold), they’d pay another $10 million in taxes. If they spend $248 million, they’d pay roughly $25 million in taxes. If they spend $268 million, they’d pay roughly $44 million in taxes. If they get under the threshold in one year, they reset their penalty structure for years to come.
■ BIGGER DRAFT/INTERNATIONAL PENALTIES FOR SIGNING FREE AGENTS: Teams that go past the threshold in one year and then sign a free-agent who receives a qualifying offer the following offseason face greater losses in draft picks and international bonus pool money than teams that stay below the threshold.
If the Sox go past the luxury tax threshold in 2020 with Mookie Betts on the roster, watch Betts leave in free agency after the season, and want to sign (for instance) fellow free agent George Springer to replace him, the team would have to give up a second- and fifth-round pick while also losing $1 million in international bonus pool money to add Springer. If the Sox wanted to sign Springer after staying below the threshold in 2020, their penalty would be a second-round pick and $500,000 in international pool money.
■ LESS DRAFT COMPENSATION FOR DEPARTING FREE AGENTS: A team that spends beyond the luxury tax threshold gets less draft-pick compensation for a departing free agent who receives a qualifying offer. If the Sox spend beyond the threshold in 2020 with Betts on the roster and then watch him leave in free agency, they’d get a draft pick between the fourth and fifth rounds. If the Sox get under the threshold in 2020, a departure by Betts would net the team a pick between the second and third rounds.
■ MORE DRAFT PICK PENALTIES FOR BIG SPENDERS: Teams that spend beyond the third and highest threshold ($248 million in 2020) face a 10-pick penalty with their highest draft pick.
■ REDUCED REVENUE SHARING REBATES: This is perhaps one of the most significant and least discussed or understood aspects of team decision-making.
Larger-market teams that repeatedly spend past the threshold would forfeit a “market disqualification refund” on potentially sizable revenue sharing rebates – something that is significant in the decision-making of teams that traditionally rank among the biggest spenders and drivers of free agent contracts.
The 2012-16 CBA first introduced the possibility of a revenue-sharing rebate for large-market teams that stayed below the threshold – but that was viewed as somewhat disappointing by the Yankees and Red Sox, the biggest revenue-sharing contributors.
For years, the A’s – despite residing in what MLB and the MLBPA characterize as one of the bigger markets in the game – had received massive revenue-sharing subsidies of tens of millions of dollars annually due to a dismal, revenue-starved stadium. But the 2017-21 CBA decided that after years of such subsidies, Oakland needed to start standing on its own financial feet, resulting in a phase-out of its eight-figure annual payout. In 2017, Oakland’s revenue-sharing allowance was reduced by 25 percent; in 2018, by 50 percent; in 2019, by 75 percent; next year, it will be phased out completely.
The money that had been earmarked for the A’s will go back to the other 12 teams located in above-average market sizes, with payouts proportionate to revenue-sharing contributions. The Red Sox are believed to be a top-three contributor to revenue sharing, and thus would be entitled to one of the biggest payouts.
But teams that spend past the threshold – even by $1 – for at least two straight years will forfeit some to all of that refund. A team that goes past the threshold two straight years (such as the 2018-19 Red Sox) loses 25 percent of its refund in the second year; that penalty increases to 50 percent when paying the luxury tax a third straight year, 75 percent in a fourth straight year, and 100 percent when going over the threshold in five straight seasons.
How big is the penalty? According to multiple major league sources, the Sox’s forfeiture of 25 percent of their 2019 revenue-sharing rebate will be in the low seven figures. If they reset their penalties by staying below the threshold in 2020, they’d ensure their full rebate next year and in 2021.
Consider two scenarios: In one, the Red Sox maintain a $243.5 million payroll in 2020, 2021, and 2022. In the other, the team spends $205 million in 2020 then returns to $243.5 million in 2021 and 2022.
Using a speculative low-seven figures rebate loss of $2.25 million for 2019, the Sox would lose $27 million in revenue sharing rebates over the next three years if they stay over the threshold. By getting under the threshold this year, they’d reduce that figure to $3 million.
Using the budget scenario, the revenue sharing difference would come on top of what could be $35 million in luxury tax differences over the next three years (that assumes the next CBA would feature modest threshold growth to $212 million in its first year) – not to mention the $35 million in diminished payroll spending in the 2019 season. Put that together – the payroll commitments, luxury tax payments, and lost revenue sharing rebates – and the Red Sox could be looking at a $95 million difference in spending over the next three years if they get under the luxury tax threshold this year before returning to 2019 spending levels in 2021 and 2022.
Certainly, it’s fair to wonder whether teams can afford such penalties, particularly given the potential rewards of winning. After all, as agent Scott Boras points out, the Red Sox were willing to pay a $31.5 million penalty to sign Yoan Moncada as an international amateur in 2015. (The team also continues to pay Rusney Castillo to languish in Triple-A Pawtucket. He’ll come off the books after 2020.) Other teams, including the Cubs, Yankees, Dodgers, Padres, and others likewise spent tens of millions of dollars in international amateur penalties under the 2012-16 CBA.
“We’ve got multiple teams that are spending above the market, paying exorbitant penalties to do this, and yet they’re not doing it annually with the luxury tax?” said Boras. “That’s why the rights of free agents have been trampled: They’ve spent money on other acquisitions of players but they won’t spend it on free agents. That’s the paradigm of why the luxury tax concept has changed so much since its inception. The purpose of it is now completely different than it was when they tried to go in and put the guardrails on George Steinbrenner.
“All those teams paid $30 or $40 million in taxes to [sign international amateurs] – to bring in a player who was not a major leaguer. Yet we’re watching teams say, ‘I’m not going to spend $10 or $15 million more above the luxury tax to have a great chance to win a world championship.’”
Every team has a self-defined budget limit, and the CBA has created enough disincentives to going over the threshold and incentives to stay under it that it appears to have impacted the way that teams are approaching it.
“It was understood [in the 1990s] that the luxury tax would not operate as a salary cap. That has been forgotten on the club side,” said former union associate general counsel Gene Orza. “It’s understandable. They’re making a lot of money by forgetting. Amnesia is economically worthwhile for them. It comes with little cost.”